Traders work at the New York Stock Exchange on 9 August. Photograph: Stan Honda/AFP/Getty Images

For the past two centuries and more, life in Britain has been governed by a simple concept: tomorrow will be better than today. Black August has given us a glimpse of a dystopia, one in which the financial markets buckle and the cities burn. Like Scrooge, we have been shown what might be to come unless we change our ways.

There were glimmers of hope amid last week’s despair. Neighbourhoods rallied round in the face of the looting. The Muslim community in Birmingham showed incredible dignity after three young men were mown down by a car and killed during the riots. It was chastening to see consumerism laid bare. We have seen the future and we know it sucks. All of which is cause for cautious optimism – provided the right lessons are drawn.

Lesson number one is that the financial and social causes are linked. Lesson number two is that what links the City banker and the looter is the lack of restraint, the absence of boundaries to bad behaviour. Lesson number three is that we ignore this at our peril.

To understand the mess we are in, it’s important to know how we got here. Today marks the 40th anniversary of Richard Nixon’s announcement that America was suspending the convertibility of thedollar into gold at $35 an ounce. Speculative attacks on the dollar had begun in the late 1960s as concerns mounted over America’s rising trade deficit and the cost of the Vietnam war. Other countries were increasingly reluctant to take dollars in payment and demanded gold instead. Nixon called time on the Bretton Woods system of fixed but adjustable exchange rates, under which countries could use capital controls in order to stimulate their economies without fear of a run on their currency. It was also an era in which protectionist measures were used quite liberally: Nixon announced on 15 August 1971 that he was imposing a 10% tax on all imports into the US.

Four decades on, it is hard not to feel nostalgia for the Bretton Woods system. Imperfect though it was, it acted as an anchor for the global economy for more than a quarter of a century, and allowed individual countries to pursue full employment policies. It was a period devoid of systemic financial crises.

Utter mess

There have been big structural changes in the way the global economy has been managed since 1971, none of them especially beneficial. The fixed exchange rate system has been replaced by a hybrid system in which some currencies are pegged and others float. The currencies in the eurozone, for example, are fixed against each other, but the eurofloats against the dollar, the pound and the Swiss franc. The Hong Kong dollar is tied to the US dollar, while Beijing has operated a system under which the yuan is allowed to appreciate against the greenback but at a rate much slower than economic fundamentals would suggest.

The system is an utter mess, particularly since almost every country in the world is now seeking to manipulate its currency downwards in order to make exports cheaper and imports dearer. This is clearly not possible. Sir Mervyn King noted last week that the solution to the crisis involved China and Germany reflating their economies so that debtor nations like the US and Britain could export more. Progress on that front has been painfully slow, and will remain so while the global currency system remains so dysfunctional. The solution is either a fully floating system under which countries stop manipulating their currencies or an attempt to recreate a new fixed exchange rate system using a basket of world currencies as its anchor.

The break-up of the Bretton Woods system paved the way for the liberalisation of financial markets. This began in the 1970s and picked up speed in the 1980s. Exchange controls were lifted and formal restrictions on credit abandoned. Policymakers were left with only one blunt instrument to control the availability of credit: interest rates.

For a while in the late 1980s, the easy availability of money provided the illusion of wealth but there was a shift from a debt-averse world where financial crises were virtually unknown to a debt-sodden world constantly teetering on the brink of banking armageddon.

Currency markets lost their anchor in 1971 when the US suspended dollar convertibility. Over the years, financial markets have lost their moral anchor, engaging not just in reckless but fraudulent behaviour. According to the US economist James Galbraith, increased complexity was the cover for blatant and widespread wrongdoing.

Looking back at the sub-prime mortgage scandal, in which millions of Americans were mis-sold home loans, Galbraith says there has been a complete breakdown in trust that is impairing the hopes of economic recovery.

“There was a private vocabulary, well-known in the industry, covering these loans and related financial products: liars’ loans, Ninja loans (the borrowers had no income, no job or assets), neutron loans (loans that would explode, destroying the people but leaving the buildings intact), toxic waste (the residue of the securitisation process). I suggest that this tells you that those who sold these products knew or suspected that their line of work was not 100% honest. Think of the restaurant where the staff refers to the food as scum, sludge and sewage.”

Finally, there has been a big change in the way that the spoils of economic success have been divvied up. Back when Nixon was berating the speculators attacking the dollar peg, there was an implicit social contract under which the individual was guaranteed a job and a decent wage that rose as the economy grew. The fruits of growth were shared with employers, and taxes were recycled into schools, health care and pensions. In return, individuals obeyed the law and encouraged their children to do the same. The assumption was that each generation would have a better life than the last.

This implicit social contract has broken down. Growth is less rapid than it was 40 years ago, and the gains have disproportionately gone to companies and the very rich. In the UK, the professional middle classes, particularly in the southeast, are doing fine, but below them in the income scale are people who have become more dependent on debt as their real incomes have stagnated. Next are the people on minimum wage jobs, which have to be topped up by tax credits so they can make ends meet. At the very bottom of the pile are those who are without work, many of them second and third generation unemployed.

Deep trouble

A crisis that has been four decades in the making will not be solved overnight. It will be difficult to recast the global monetary system to ensure that the next few years see gradual recovery rather than depression. Wall Street and the City will resist all attempts at clipping their wings. There is strong ideological resistance to the policies that make decent wages in a full employment economy feasible: capital controls, allowing strong trade unions, wage subsidies, and protectionism.

But this is a fork in the road. History suggests there is no iron law of progress and there have been periods when things have got worse not better. Together, the global imbalances, the manic-depressive behaviour of stock markets, the venality of the financial sector, the growing gulf between rich and poor, the high levels of unemployment, the naked consumerism and the riots are telling us something.

The number of people filing new claims for jobless benefits jumped last week after three straight declines, another sign that the pace of layoffs has not slowed. Gerald Celente says that there is no way governments can just keep pumping money into the economy and it will only get worse, with an eventual crash.

The E.U. logo reflects in a window opposite the European Central Bank's headquarters in Frankfurt on Aug. 09, 2011

It may be called the European Union, but at least part of that name is being called into question. The market convulsions of the past week are clearly about short-term concerns, about the balance sheets of countries like Italy, Spain and even France. But they’re also about a problem with a more distant horizon: Does the E.U. still make sense in its current form?

As long as that question remains unanswered, uncertainty is bound to continue. Short-term measures, like the propping up of Spanish and Italian bonds by the European Central Bank “are quick fixes that smooth things over the short term,” says Stephen King, chief economist at HSBC in London. “But they don’t answer the questions the markets are asking: What are the political and fiscal arrangements that would create stability in the future?”

The trouble is one that was identified long ago. The E.U. has created a single currency, but it hasn’t forged a deeper political or fiscal union. The result has been the creation of a system that yokes individual countries to a single unified monetary policy, without allowing for the transfer of funds that would allow the union’s member states to ride out the distortions that setup can create. As a result, consensus is mounting that the current situation is simply not sustainable. The E.U., says a rising chorus of voices, needs either to be strengthened, or it will break apart. “What needs to happen is that there’s an honest recognition that those two choices exist and that a choice has to be made,” says King. “Pretending we’re going to muddle through just won’t work.”

The E.U., as is stands, “is a fair-weather construction,” says Emma Bonino, the vice president of the Italian Senate and a former commissioner at the E.U. “It works only in the absence of economic trouble.” The solution, she argues, is the further centralization of political power. Such a move wouldn’t have to be the creation of a single European superstate along the lines of the U.S. Bonino herself has proposed an intermediate solution, in which member states cede only some of their powers — such as foreign policy, defense and border control. Most crucially, it would include a Finance Ministry in charge of economic stabilization, and, when needed, transfers of funds from the central government to individual states. The common political identity, she argues, would make the necessary redistribution more palatable. “Help normally comes only if there is a shared feeling of belonging,” she says.

The other possibility — argued most loudly in Germany, where anger is mounting about taxpayers being forced to bail out less-responsible countries like Greece or Ireland — is to start to break the union apart. “It is better for all concerned, in particular for Greece, if the country leaves the euro temporarily,” Hans-Werner Sinn, an influential economist at the University of Munich, wrote in a recent essay. The weaker country would be free to devalue its currency and begin to regain its competitiveness. The rest of the E.U. wouldn’t be forced to come to its assistance. Even Otmar Issing, a former member of the European Central Bank and one of the driving forces behind the single currency, has warned against the rushed strengthening of the union. A proponent of European integration who once famously cautioned that “there is no example in history of a lasting monetary union that was not linked to one state,” Issing now worries that a bailout of Europe’s less solvent members would lead to “fiscal indiscipline” and even unrest by taxpayers furious over being forced to sacrifice when others didn’t.

Both choices have historical precedents, says HSBC’s King. After the collapse of the Soviet Union, countries that for decades were united under a single political authority suddenly weren’t. Many of the newly formed, previously Soviet republics first tried to keep using the Russian ruble. But soon, in a development that should give pause to anybody watching the E.U., the economic discrepancies between the various economies became too great. And the single currency fell apart.

A model for the alternative scenario is the E.U. itself. Before the introduction of the euro, the European Community had introduced a currency mechanism intended to reduce the variability in exchange rates between the various member countries. In 1992, however, that system began to fail. In a sequence of events that would seem familiar to anyone watching the markets this week, speculation sent the market into a frenzy. The U.K., which had joined the mechanism two years earlier, hastily withdrew. The other countries drew the opposite lesson and pledged to move toward closer economic integration. “The single currency wouldn’t have happened without that crisis,” says King. “The crisis reveals the choice, and the choice has to be made.”

“Obamageddon — that’s what we have witnessed since Friday,” Rush told his listeners on Monday.

“Obamageddon. Barackalypse Now. The only silver lining I can find is that as far as 2012 goes, Obama’s a Debt Man Walking. Anybody want to tell me he’s not landslidable now?

“Let me repeat this as the Media Tweak of the Day: ‘What we have witnessed since Friday is Obamageddon, Barackalypse Now. And the only silver lining out there is that as far as 2012 goes, Obama’s now Debt Man Walking.”

In his blistering attack on Obama and the Democrats, Limbaugh asserted that “we have a president that’s overseeing — engineering — the decline of the American republic.”

He also charged that Democrats are trying to play the blame game against Republicans over the financial crisis.

“Obama is always running around complaining and whining and moaning about all that he inherited from George W. Bush,” Rush said.

“Well, he inherited a AAA credit rating, an unemployment rate of 5.7 percent.

Limbaugh’s comments came the Monday after Standard & Poor’s downgraded the U.S. credit rating from AAA to AA-plus , and the Dow tanked 634 points. Obama blamed the downgrade on political gridlock in Washington and said he would offer some recommendations on how to reduce federal deficits.

Obama stopped short of sharp criticism of Standard & Poor’s for its downgrade of U.S. debt to AA-plus from AAA on Friday. Senior administration officials have accused S&P of going ahead with the downgrade despite a $2 trillion mathematical error.

“Markets will rise and fall, but this is the United States of America. No matter what some agency may say, we have always been and always will be a triple-A country,” Obama said.

As Obama spoke, stock markets were registering another steep decline, dropping more than 450 points in afternoon trading.

A joint bipartisan congressional committee, to be formed under the legislation passed last week that averted a government default, is to report its recommendations in late November on how to cut $1.5 trillion in spending over a decade.

Obama said he would offer his own recommendations for fixing the problem and cited again the need to raise taxes on wealthier Americans and make modest adjustments to popular but expensive entitlement programs.

Limbaugh took the president’s comments about the S&P, and threw them right back.

“So go ahead and blame Standard & Poor’s all you want, Democrats. Now they’re blaming the military! Barney Frank and the Democrats are trying to say it’s the military’s fault that we’ve been downgraded.

“This is the fault of the Democrat Party,” Limbaugh said, exasperated.

Limbaugh went on to say: “So now we know what Obama got for his birthday: A downgrade of our credit rating, probably exactly what he wanted in his heart of hearts . . .

“World War II, we had a AAA credit rating, and we lose it now, and for what? For what great purpose did we lose it? Except an ideological hatred of American capitalism and a love of class warfare, what did we lose our AAA rating for?

“Think about it: Obama’s finally managed another major accomplishment on that list he told us he had, that list that he said he’d only done about 70 percent so far. At long last, Obama and his fellow Democrats have finally been able to convince the world that we are just another country, after all. There’s nothing exceptional about us or our economy.

“For crying out loud, France has a higher credit rating than we do. France! They produce cheese and perfume, for crying out loud!”

But one person who does not buy into the theory that Obama is deliberately undermining the economy is Donald Trump. The billionaire developer said on Monday that the president is incompetent not malicious.

“There is a theory that he is doing it on purpose but I absolutely do not believe that. He’s just ill-equipped to be president,” Trump told New York’s WOR radio. “Tremendous wrong moves are being made.”

Host Steve Malzberg asked him if he thinks that Obama takes a sip of champagne every time a trillion dollars goes out of the economy.
“No, I really don’t,” replied Trump. “You just have a president who is not doing a good job.”

Having Standard & Poor’s downgrade the creditworthiness of the U.S., and warn the country about further downgrades, is a little like having the Catholic Church lecture Scout leaders on the proper behavior toward boys. The moral authority seems to be wanting. S&P, you may recall, is one of the ratings agencies (the others being Moody’s and Fitch) that greased the skids of the financial crisis by awarding AAA ratings to tranche after tranche of mortgage bonds called collaterized debt obligations, or CDOs.

Recall that, unlike U.S. Treasuries, backed by the full faith and credit of the U.S., CDOs were underwritten by garbage mortgages — that is, backed by no-documentation “liar loans” and other Alt-A subprime pond scum handed to borrowers who otherwise couldn’t get a nickel’s worth of credit at their local dry cleaner. S&P stamped CDOs with the same grade it previously awarded to a precious few companies, including Exxon and Microsoft. More than 30,000 CDOs got the AAA blessing from the agencies. S&P couldn’t pull its snout out of the trough even when it became apparent in 2007 that the mortgage bond pig-out was over. This e-mail from an S&P employee, uncovered by a congressional investigation, says it all: “Let’s hope we are all wealthy and retired by the time this house of cards falters.” In their absorbing history of the financial crisis, The Devils Are All Here, Bethany McLean and Joe Nocera bared the behavior of the agencies.

Even when their own analysts began sounding the alarm, senior management refused to stop the money machine. And if the analysts became insistent on being scrupulous, the agencies got new analysts. Why? Because their clients, big banks such as Lehman Brothers and Goldman Sachs, demanded that the CDO machine keep on cranking, until it utterly collapsed.

And let’s be clear: this was all perfectly legal. “S&P’s ratings do not speak to the market value of a security or the volatility of its price, and they are not recommendations to buy, sell or hold a security. They simply provide a tool for investors to use as they assess risk and differentiate credit quality of obligors and the debt they issue,” testified Rodney Clark, head of ratings services for S&P, to the House subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises. In other words, you can’t take our word to the bank, but you can take it to the poorhouse.

When investors like the Wyoming state pension system sued after many of the CDOs crashed in value, the industry stuck to this “It’s just our opinion” defense and won. The U.S. Second Circuit Court of Appeals ruled last August that the agencies were not “underwriters” or “control persons” even if they were in bed with them. The fundamental contradiction of the industry is that the companies that issue the securities pay the ratings agencies for their grades; independence is always suspect, and the courts upheld that.

One of many ironies of the S&P downgrade is that the three ratings agencies have so much power because the federal government, in the form of the Securities and Exchange Commission (SEC), handed it to them. As former TIME writer Barbara Kiviat pointed out in this space, the power of the big ratings agencies dates to the post-Depression era, when the government increasingly relied on them to bless new issues for credit-wary investors. Then, in 1975, the SEC iced the cake, designating a number of companies as “nationally recognized statistical rating organizations,” or NRSROs. If you were not an NRSO as a ratings agency, you were SOL. Why would anyone issue bonds rated by an agency that wasn’t government-approved? The SEC designation had the unintended effect of creating a market lock for the bigger firms. That S&P would slap the hand that legitimizes it is wonderfully perverse given last week’s debt deal. The Tea Party supposedly hates Wall Street so much that it ignored warnings that its Taliban economic policy — threatening to decapitate the economy unless it got its way on spending cuts — would spook the markets, since the Street abhors uncertainty. For a moment, it looked as if the Tea team won, in that the market didn’t tank as the deal wrangling went on and on. Instead, the market cratered post-deal, as the compromised compromise left so much up in the air. Republicans had been chastising the Obama Administration for creating uncertainty, yet they allowed their own radical wing to impose it for the foreseeable future. (Clearly, uncertainty about the resolution of Europe’s sovereign debt crisis contributed to the market troubles too.) So S&P in effect fired a shot across the Tea Party’s bow: You mess with Wall Street, you will be punished. It had another for Obama: Lead, follow or get out of the way. And the two parties blamed each other. “It happened on your watch, Mr. President,” screamed Michele Bachmann, exhibiting the full extent of her knowledge of economics. In making its decision, S&P said the downgrade “reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.”

Here’s the other laughable irony: Congress had a chance to rein in the ratings agencies but demurred. Even though the statutory authority that gave S&P, Moody’s and Fitch an oligopoly on ratings was complicit in their contribution to the crisis, Congress nevertheless refused to remove the NRSRO status. The solons bought the idea that smaller agencies would be crushed if an unfettered free market were imposed on the ratings industry. Funny, that didn’t happen in the airline industry when it was deregulated. And by the way, can you name the fourth, fifth or sixth largest ratings agency? Republicans, heeding the deregulation call of their banking clients (whose demands for deregulation more than a decade ago, blessed by the Clinton Administration, led us down the path to the crisis), bent over backward to defang the Consumer Financial Protection Bureau, which was central to the Dodd-Frank bill, whose hilarious formal name is the Dodd-Frank Wall Street Reform and Consumer Protection Act. Wall Street, having blown trillions during the crisis, demanded not to be hampered by either reform or consumer protection as it recovered from the crisis. Why should the ratings agencies be so encumbered?

So here’s our reward, America: higher costs for our mortgages and higher costs for the federal, state and local governments to borrow. As Fareed Zakaria points out in TIME’s Aug. 15 cover story, a jump of a single percentage point in the interest rate the federal government pays will more than wipe out the savings anticipated by the debt deal. Nice work, that. And we owe it all to an ethically and intellectually suspect ratings agency. (S&P even made a $2.1 trillion error in its calculations but dismissed it as “nonmaterial.”) Yet it has occurred to me that maybe S&P has a point. After all, this is a Congress that let the banking industry run amok, bailed it out with access to trillions of dollars of credit and has since done precious little to ensure that the process won’t be repeated. Nor would Congress reform the ratings industry, which played a vital role in the crisis. Nor did it agree to a deal worked out between Obama and House Speaker John Boehner that would have preserved the AAA rating. If our Congress is that dumb, perhaps we deserved the downgrade.

With the US raising their debt ceiling, are we in a global bail-out bubble that will eventually burst? This doc offers a fresh insight into the greatest economic crisis of our age: the one still awaiting us.

The financial storm that has rocked the world began brewing in the US when congress pushed the idea of home ownership for all, propping up those who couldn’t make the down payments. When it all went wrong the government promised the biggest financial stimulus packages in history and gargantuan bailouts. But what crazed logic is that: propping up debt with more debt? “They’re giving alcohol to a drunk: it just sets him up for a bigger hangover.”

This 45 minute documentary is well worth watching to get a better understanding of the smoke and mirrors of politics and the world’s economic processes.